The trouble until retirement is you never seem to get a day off. You aren't alone if you are looking forward to the days where you can pursue your new found passion full time, whatever it may be. I am talking about the staple of the retirement diet: hobbies. I like to think that people don't retire from anything, they retire to it and preoccupations become occupations. Hobbies are fun. All of them require money, time, expertise, organization, and sometimes they even turn a profit. Wait a second; this is starting to sound like an actual business doesn't it? So if you are generating an income with a hobby does that mean it qualifies it for the preferential tax treatment of a business? The answer is... maybe.
The reason one would prefer to be treated as a business rather than a hobby is simple–tax savings. By treating your hobby as a business you now have the ability to use the IRS allowed losses generated to lower other income, lowering taxes overall for the year. A very attractive proposition for doing something you already love. A hobby can only use losses it generates against its own income, so a hobby does not have the capability to lower taxes. Why is this? A hobby typically isn't something you enter into with the express intent of earning a profit; a business by definition is something you enter expressly for profit. This means the expenses incurred by a business are for the production of income and thus deductible against income lowering taxes for that year. Can anybody treat a hobby as a business? The answer is no. In order for an activity to be treated as a business there are several criteria that must be met that will indicate a true motive for profit. The IRS has 9 factors it uses to clearly identify a business plus an earnings test. The earnings test requires you to be profitable 3 out of the last 5 years or 60% of the time (2 out of 7 for horse breeding). And it seeks to identify business elements that a hobby doesn't have like a business plan, profit forecasts, bank accounts, assets, and detailed books to name a few.
I am sure you have already noticed it is very easy to quickly tell a hobby from a business. For many, hobbies simply don't qualify as a business. However, if your passion starts turning
into a profession it may make sense to take a closer look and potentially formalize the operation. In order to be treated as a business it takes more than just income... and let's face it–why would you want it to be a business... You're retired!!!